The Impact of Financial Disclosure Complexity on Bond Rating Agency Disagreement and the Cost of Debt Capital

Abstract

This study examines whether the readability of financial disclosures impacts bond ratings and rating agency disagreement. We find that less readable financial disclosures are associated with more unfavorable ratings (higher default risk) and greater bond rating agency disagreement, both outcomes which impose significant costs on issuers. To address the potential confound that our results may be influenced by some underlying firm characteristic (e.g., firm complexity), we take advantage of an exogenous mandatory shock provided by the 1998 Plain English Mandate requiring firms issuing prospectuses to write using plain English. Using a difference-in-differences design, we find that, compared to the annual filings of bond issuing firms that did not file prospectuses, bond issuing firms that filed prospectuses exhibit a greater improvement in the readability of their annual filings and correspondingly fewer unfavorable ratings (lower default risk) and lower bond rating disagreement. Collectively, our evidence suggests that textual financial disclosure attributes appear to influence their opinions.